UK, EU Must Grapple With Implications of OECD Side-by-Side Deal

The OECD’s new “side-by-side” deal exempts US-headquartered multinationals from much of its global minimum tax rules. The UK government has announced that it will implement this deal through new domestic legislation (retroactive to Jan. 1). The EU plans to implement it as well, likely through treating the new safe harbor as consistent with existing exemptions rather than trying to amend the Pillar Two directive that created the minimum tax regime.

In a sense, the side-by-side deal is a classic compromise: It allows the Organization for Economic Cooperation and Development to continue its Pillar Two project, reducing risk of US retaliation and sparing US multinationals—who already file under a 15% domestic book minimum tax and assess low tax income of foreign subsidiaries—from complying with a different set of rules that look to ensure profits are taxed at a minimum 15% rate worldwide.

Given that pragmatism has overtaken principle in reaching this deal, we see several policy and practical challenges for the UK and other European jurisdictions.

The first and most direct consequence is a potential loss of tax revenue. The UK, like certain EU states, is a popular sub-holding company jurisdiction for US multinationals. Under Pillar Two as originally designed, the UK could top up any low tax profits in subsidiaries held beneath the UK as an intermediate holding company jurisdiction (that is, as a fallback when the US parent doesn’t apply the Pillar Two income inclusion rule).

The side-by-side deal reverses that outcome: There might be some level of pick up in the US, but the UK can’t tax any shortfall.

It will be interesting to see what impact that has on estimates of revenue generated for the UK under the Pillar Two rules; An early UK government estimate was £2 billion ($2.7 billion) in additional taxes per year for the entire Pillar Two package including the income inclusion rule and qualified domestic minimum top-up tax, before the side-by-side carve out.

For non-US groups that are struggling under the burden of Pillar Two, a new opportunity arises: Should they look to invert into the US, rather than the other way around, as has long been the trend? We think there are enough factors that weigh against this to make it of interest only to a minority of multinationals, such as the complexity of the US system or the fact that once established in the US it is said to be difficult for companies to leave.

But if a group has other reasons for considering establishing in the US, such as access to its capital markets and higher valuations for listed stocks, there is now one more pull factor: For a group with a US parent company, most of the complexity associated with Pillar Two will no longer apply.

For members of the OECD Inclusive Framework who are keen to preserve the achievements of the Pillar Two project, there is one important set of rules from which US multinationals won’t be exempted.

Pillar Two was designed to incentivize low- or no-tax jurisdictions to bring in domestic corporate taxes at a minimum rate. Many have done so, including jurisdictions in the Channel Islands or the Middle East that hadn’t previously sought to tax multinationals at the 15% minimum rate. US groups won’t be exempt from these new domestic taxes, so even with the side-by-side exemption there is an increase in foreign taxes collected from US-headquartered groups.

What the Pillar Two project hasn’t done, however, is persuade the US to align aspects of its rules with minimum standards being adopted elsewhere.

One example is global intangible low-taxed income, now called net controlled foreign corporation tested income, or NCTI, which still allows US multinationals to “blend” their low tax overseas income with higher taxed profits in other jurisdictions. Pillar Two, in contrast, doesn’t allow for this averaging effect, instead requiring that the profits of every jurisdiction are taxed at 15%.

On this occasion, the UK and EU have decided not to let the perfect be the enemy of the good. It’s a compromise, but one that they can accept to keep the Pillar Two project alive in a difficult international political environment.

The new agreement is unlikely to be the final chapter in this saga. It’s worth noting that all Inclusive Framework countries, including China and India, have signed this deal despite initial reservations. We eventually will see whether other jurisdictions’ tax systems will be eligible for the side-by-side safe harbor.

Other aspects of the side-by-side deal are also worth monitoring as well. The introduction of the new safe harbor for certain tax incentives linked to real economic activity has the potential to reintroduce tax competition that the Pillar Two rules sought to contain.

Finally, although the deal signals that international tax cooperation remains possible, the resurging threat of tariffs may change this dynamic.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Gregory Price is a partner with Macfarlanes.

Elvira Colomer Fatjó is an associate with Macfarlanes.

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